Over­com­ing your wealth-de­stroy­ing in­stincts

At the fi­nal round of ac­sis/Per­sonal Fi­nance Fi­nan­cial Plan­ning Club meet­ings for the year, ac­sis chief ex­ec­u­tive An­drew Bradley fo­cused on your base in­stincts – such as fear – and how th­ese should be tamed if you want to be a suc­cess­ful long-term in­vesto

Weekend Argus (Saturday Edition) - - GOODPASTIMES -

In­vest­ment mar­kets per­form well over time, but many in­vestors fail. The rea­son is that many in­vestors de­stroy their own po­ten­tial wealth through their be­hav­iour, An­drew Bradley, the chief ex­ec­u­tive of­fi­cer of fi­nan­cial plan­ning com­pany ac­sis told the re­cent round of ac­sis/Per­sonal Fi­nance Fi­nan­cial Plan­ning Club meet­ings.

Bradley says that de­spite the fact that our gen­er­a­tion, on av­er­age, is en­joy­ing the high­est level of af­flu­ence ever, has much bet­ter ed­u­ca­tion than pre­vi­ous gen­er­a­tions and hence much bet­ter fi­nan­cial lit­er­acy, and a huge range of fi­nan­cial prod­ucts and providers from which to choose, most South Africans are chron­i­cally un­der-in­sured, un­der-saved and un­der-in­vested.

The key rea­son, he says, is our be­hav­iour and psy­chol­ogy.

South African unit trust funds have shown a long-ter m av­er­age re­tur n of 9.4 per­cent a year over rolling five-year pe­ri­ods, but the av­er­age unit trust in­vestor has ear ned only 4.1 per­cent a year over the same rolling pe­ri­ods, he says.

This is be­cause in­vestors tend to in­vest and then pull out at the wrong time in the in­vest­ment cy­cle. When in­vest­ment mar­kets are fall­ing they tend to suc­cumb to grow­ing con­cern, which leads them to dis­in­vest at or near the bot­tom of the mar­ket’s down­ward cy­cle, Bradley says.

They then watch the mar­ket’s tur naround with con­tempt and re­gain suf­fi­cient con­fi­dence to en­ter the mar­ket again only when it is at or near its peak, he says.

This means they sell their in­vest­ments at the bot­tom of the mar­ket, when prices are at their low­est, and in­vest again when prices are high or near the top of mar­ket.

The re­sult is that, on av­er­age, they en­joy much weaker per­for­mance than that pro­duced by a fund that stays in­vested in the mar­ket through­out its cy­cles.

In the same way that poor phys­i­cal health is of­ten caused by in­ap­pro­pri­ate be­hav­iour, so too is poor fi­nan­cial health, Bradley says.

The driv­ers of our bad be­hav­iour are fac­tors such as peer pres­sure and sta­tus, un­cer­tainty and a lack of con­trol, the de­sire to live for to­day, an aver­sion to suf­fer­ing losses, over­con­fi­dence, and us­ing price as a proxy for qual­ity (we are pre­pared to pay higher prices be­cause we think it means we will get qual­ity, but this isn’t al­ways the case with shares).

Bradley gave an ex­am­ple of an in­vestor who de­stroyed his own po­ten­tial wealth by pan­ick­ing at the beginning of this year as a re­sult of the im­pact of the credit cri­sis on the mar­kets (See Ex­am­ple 1, right).

He says that while many peo­ple de­stroy their wealth by mov­ing in and out of mar­kets at the wrong time (See Ex­am­ple 2), not stay­ing in­vested for long enough can have the same ef­fect.

The longer you stay in an in­vest­ment, Bradley says, the more sta­ble your re­turn is likely to be (See Ex­am­ple 3).

Any­one who in­vested be­tween just over four and 15 years ago and has re­mained in­vested has en­joyed an av­er­age an­nual re­turn of 15 per­cent or more, he says. Over shorter ter ms, how­ever, re­tur ns are lower. (See top graph).

Many peo­ple think they can time the mar­kets, in­vest­ing when the mar­ket is go­ing up and dis­in­vest­ing when it is fall­ing. But they usu­ally de­stroy wealth when at­tempt­ing to do this (See Ex­am­ple 5).

Bradley says the prob­lem with tim­ing the mar­ket is that you don’t only need to know when to get out of the mar­ket, but when to go back in.

Even ex­pe­ri­enced fund man­agers can­not make th­ese calls with ac­cu­racy, he says.

About judg­ing the best time to go back into the mar­ket, Bradley says you should con­sider the sce­nario in Ex­am­ple 4. This shows how wait­ing for signs of a re­cov­ery be­fore you rein­vest can re­sult in your buy­ing in at a higher price and miss­ing much of the ben­e­fit of the up­turn.

Bradley says some peo­ple get mar­ket tim­ing right once but hardly ever twice. It is eas­ier, he says, to fore­cast the weather.

It is much bet­ter to harness the power of the mar­kets by stay­ing in­vested in them for the long term, Bradley says.

Our brains are back­ward-looking, pat­tern-seek­ing sys­tems, while mar­kets are for­ward-looking pric­ing sys­tems, Bradley says. You need to make sure your back­ward-looking, pat­tern-seek­ing brain looks at the right pat­tern, he says.

Looking at the mar­ket’s per­for­mance over the past 10 or 20 years shows a gen­eral up­ward trend in prices. A two-or even a five-year view, how­ever, may show losses and could scare you off in­vest­ing (see bot­tom group of four graphs).

To re­alise your full po­ten­tial you need to have goals and strate­gies and the con­fi­dence and sense of con­trol that al­lows you to take the ap­pro­pri­ate action to fol­low those strate­gies, Bradley says.

He says that some­times we de­stroy wealth without know­ing it, and a fi­nan­cial plan­ner who is pre­pared to ad­vise you, guide you and hold your hand through the scarier in­vest­ment times can play a crit­i­cal role in help­ing to pre­vent un­de­sir­able be­hav­iour.

A good plan­ner will help you iden­tify be­hav­iour that can de­stroy wealth and coach you through it so that you can reg­u­late your­self and de­velop de­sir­able be­hav­iour that even­tu­ally be­comes “em­bed­ded and un­con­scious”.

WORDS OF WIS­DOM

Bradley con­cluded his pre­sen­ta­tion with the words of War­ren Buf­fett, who is re­garded as one of the world’s most suc­cess­ful in­vestors. Buf­fett says: “To in­vest suc­cess­fully over a life­time does not re­quire a strato­spheric IQ, un­usual busi­ness in­sights or in­side in­for­ma­tion. What is needed is a sound in­tel­lec­tual frame­work for mak­ing de­ci­sions and the abil­ity to keep emo­tions from cor­rod­ing that frame­work.”

An­drew Bradley of ac­sis

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